Chapter 15 Price Levels and the Exchange Rate in the Long Run 国际财务相关管理课件.pptVIP

Chapter 15 Price Levels and the Exchange Rate in the Long Run The Law of One Price Purchasing Power Parity A Long-Run Exchange Rate Model Based on PPP Empirical Evidence on PPP and the Law of One Price Explaining the Problems with PPP Beyond Purchasing Power Parity: A General Model of Long-Run Exchange Rates International Interest Rate Differences and the Real Exchange Rate Real Interest Parity 15-1 The Law of One Price Law of one price Identical goods sold in different countries must sell for the same price when their prices are expressed in terms of the same currency.(P389) This law applies only in competitive markets free of transport costs and official barriers to trade. Example: If the dollar/pound exchange rate is $1.50 per pound, a sweater that sells for $45 in New York must sell for £30 in London. It implies that the dollar price of good i is the same wherever it is sold: PiUS = (E) x (PiE) where: PiUS :is the dollar price of good i when sold in the U.S. PiE :is the corresponding euro price in Europe E :is the dollar/euro exchange rate(direct quotation to U.S.) 15-2 Purchasing Power Parity Theory of Purchasing Power Parity (PPP) The exchange rate between two counties’ currencies equals the ratio of the counties’ price levels. It compares average prices across countries. It predicts a dollar/euro exchange rate of: E$/€ = PUS/PE (15-1) where: E$/€ (direct quotation to U.S.) PUS is the dollar price of a reference commodity basket sold in the United States PE is the euro price of the same basket in Europe By rearranging Equation (15-1), one can obtain: PUS = (E$/€) x (PE) PPP asserts that all countries’ price levels are equal when measured in terms of the same currency. Exercise Suppose U.S. inflation rate is 10 percent over one